November 2022 crypto interest update

In light of the collapse of the crypto interest industry in November 2022, PROHASHING and author Steve Sokolowski are commencing litigation against multiple lenders and individuals discussed in these articles. These posts are outdated and will not be updated due to the ongoing legal actions. You should not rely on the information presented here. PROHASHING and the author are no longer able to respond to comments and support tickets regarding crypto interest companies.

 

Read the previous article in this series

It's time for the monthly update on earning crypto interest.  The industry has largely remained stable during the past month.  A few developments have occurred that change the relative standing of the companies, but the main theme appears to be a lack of activity in the cryptocurrency industry in general.

 

Key takeaways for November 2022

• Genesis has now supplanted BlockFi as the preferred borrower.  Genesis's rates have significantly increased during the month of October.  For Ethereum, Genesis beat BlockFi by more than 3% on some term lengths during the last week of October.  
• The change of Genesis becoming the preferred borrower is solely due to their rate competitiveness, not because of any change in risk assessment to any company.
• BlockFi remains a great option if you have less money, for specific term lengths where BlockFi is paying more than Genesis, if you want to have an option to cancel the contract, and because of BlockFi's actions in paying out free money from the ETHW fork.
• Unless Zac Prince criminally misrepresented BlockFi's financials, the bankruptcy of Core Scientific will not result in BlockFi's insolvency, even in the worst case scenario.
• Tether has a higher failure risk than is generally appreciated, and too many of the loans from all companies are backed by Tether.  Almost every centralized stablecoin is better than Tether.  There should be community pressure against the firms to stop accepting Tether as collateral and to ask borrowers to allow their Tether to be exchanged for other stablecoins.
• Ledn engaged in an E-Mail marketing campaign attesting to their low-risk lending, and 40 days have passed since they said they were gathering data for a transparency report, but one has not yet been published.

In the following sections, I will review some of the changes that have occurred during the past month.

 

Genesis's transformation

Before June 2022, Genesis's rates for fixed term loans were little different than their open-term rates.  In August and September 2022, Genesis began a switch towards paying higher rates for fixed-term loans and lower rates for open-term, but BlockFi was beating Genesis handily on rates.  Now, Genesis is almost a completely transformed business.  For the first time I can recall, Genesis is beating BlockFi for ETH loans at many term lengths.  Because Genesis's books are strong and they have many collateralized loans, ignoring their hard fork policy (see below) it might be acceptable to take a very small loss in exchange for security.  However, there are now cases where Genesis simply is paying the outright highest rate.

The yield curves for Genesis and BlockFi are different.  Genesis's curve remains inverted, with 6-month or similar terms paying the best rates.  BlockFi, like many "Silicon Valley" model firms that are more interested in equity valuation than profit, continues undoubtedly to be influenced with the FTX valuation being determined by loans outstanding on June 23, 2023, and therefore they are incentivized to get long-term loans on the books even if that results in less profit.

Unfortunately, Genesis's rate structure has not impacted Gemini users, because the massive gains are in fixed-term loans, and Gemini users do not have the option to take fixed term loans.  Gemini's rates on ETH declined by 0.25% between October 1 and November 1.  I hope that Gemini's Earn program allows its customers to pass fixed-term loans through in the future.  Regardless, BlockFi now will negotiate higher open-term rates for private clients than Gemini Earn is paying; I added a withdrawal address to move my open-term ETH out of Gemini in 7 days after their waiting period expires.

If you can't get an account at Genesis, BlockFi is still offering some of the highest rates they have ever offered, even if those rates are less than Genesis's for 4-8 month terms.  My opinion is that unless Genesis lowers its minimums, Genesis is going to struggle to maintain marketshare compared to BlockFi over the next 12 months by ignoring a large market segment - because many people who used to have $2m now have a lot less due to the stock and coin crashes.  With FTX's money to spend on sales and marketing, BlockFi is going to slowly chip away at the sub-$2m range of the market that Genesis so far is declining to pursue.

 

Non-rate advantages for BlockFi

While Genesis might be paying higher rates for some coins and for some terms, BlockFi retains and has even added some additional advantages over Genesis.

BlockFi's loan terms differ from Genesis's.  By default, BlockFi allows cancellation of a loan at any time, subject to a penalty.  Genesis does not.  One unexpected consequence of BlockFi's contract is that at present it can actually be profitable to break BlockFi ETH loans, pay the penalty, and sign a higher interest rate at Genesis, such that by the time the new term is over you'll have more money.  If you have BlockFi term loans, contact Genesis for their rates and do the math to see whether it makes sense to transfer money.  Regardless of whether this trick makes sense for you, the ability to withdrawal from BlockFi in an emergency is a significant advantage that Genesis has so far refused to consider.

A second advantage of BlockFi is their handling of the ETHW fork.  BlockFi paid its customers around $7 for every ETH they held in their account at the time of the fork, awarding us thousands of dollars of free money.  This money makes a huge difference in making payroll during these challenging times.  Genesis, on the other hand, pointed to a clause in their contract stating that they were not obligated to pay any money because the fork didn't reach 5% of ETH's value.  Genesis does allow fixed-term loans to be broken before forks, but the wording in the contract is vague, and one would have to give up days or weeks of interest, as well as the opportunity cost of potentially not getting that interest rate when the loan is renegotiated.  All that would be lost in exchange for a guess on what the value of the forked coin might be.

Genesis explained the issue by stating that their contracts with borrowers don't require the borrowers to refund them any forked coins.  That is a truthful response, but it doesn't change the outcome.  Since most forks do not result in a coin retaining 5% of its value, BlockFi's stricter terms with its borrowers generate free money for its customers.

The ETHW paid by BlockFi resulted in a net interest rate 0.5% higher than what BlockFi actually promised.  The expected value of potential forks should be considered in comparing interest rates.

 

Still waiting on Ledn

Unfortunately, the public is still waiting on Ledn to provide more information about its loan book, and therefore Ledn is still not recommended.

Ledn modified its website to add a "Learn more" page.  Ledn touts its "proof of reserves," which shows that the company actually has all the money it is lending out, and which is great information to post.  But the other items on this page focus on the things that Ledn does not do, rather than providing the full picture of what they are actually doing.  They state that they aren't engaged in DeFi, but DeFi as a whole is not a single entity.  Some DeFi contracts are buggy and poorly designed, and others are safer than lending to a person directly.  Ledn states that it only deals in bitcoin and USDC, but ETH is not an inherently risky asset.  Ledn states that they are aiming to ensure that net equity exceeds net exposure, which is not a statement that equity always or even currently exceeds exposure.

The one significant statement that Ledn does imply is that the company does not deal in Tether.  That alone improves Ledn's standing, as I will discuss below.

Still, Ledn will not disclose what the actual numbers backing all of these claims are.  It's not acceptable anymore to make vague statements about exposure without providing a concrete figure.  We don't even know the most basic information, like how large Ledn's loan book is.  Since there are competitors who have published their numbers, I refuse to lend money to Ledn until they release actual concrete data.

 

Core Scientific bankruptcy

Core Scientific is a bitcoin mining firm that made a catastrophically stupid decision to expand a mining operation as the price of bitcoin was rising, despite the several previous cycles indicating that mining rig prices were highest after the peak as profitability started to decline.  To make things worse, Core irresponsibly took out huge amounts of debt instead of at least mining on their own dime.  All of the information about this bankruptcy is easily accessible on the first page of a Google search, so I'm not going to unnecessarily repeat here why Core is bankrupt or how much they owe to whom.

Despite BlockFi's mistake in lending to Core Scientific, however, it is unlikely that even in the worst case Core's failure will bankrupt BlockFi.

First, Core published a warning that they might have to file for bankruptcy, not that they are currently bankrupt.  The probability of their going bankrupt depends upon the price of bitcoins in the coming months.  If you agree with me that bitcoin's worst days are behind it and that last week's price action represented a decisive reversal, then price increases make bankruptcy less likely.  That said, the company continues to be so poorly managed that they might go bankrupt anyway: Core spent 1000 bitcoins and less than $3m on operating expenses in September, even though they could have saved the bitcoins and spent some of the $26.6m they had in reserve instead.  That decision alone wasted millions of dollars by spending bitcoins during the lowest point of the cycle.

Second, while Core owes BlockFi $80m, even if Core were to somehow pay absolutely nothing back to BlockFi, BlockFi would still easily be solvent.  BlockFi's balance sheet can easily withstand the hit, and even if it couldn't absorb this single loss, FTX has a significant interest in not allowing BlockFi to fail and has already extended the company a loan.

Third, BlockFi's loans to Core are secured.  I couldn't find any public information about what the collateral is.  Whatever it is, the value has probably declined enough such that the loan is now undercollateralized, but a loss of the entire $80m is very unlikely.  Even after all the collateral is sold, BlockFi is a "senior creditor," which gives the company priority over other unsecured creditors in recovering the remaining amount.  Some of the junior creditors likely to be 100% wiped out are those who gave the company "shareholder loans" that are listed in the company's public statements.

Fourth, the money isn't due to BlockFi until 2024, so a complete failure of Core couldn't cause insolvency for a long time unless BlockFi is misrepresenting its books.  BlockFi isn't expecting the money to be repaid now anyway, so next year's interest payments aren't at risk due to whatever happens at Core.

Fifth, the loan to Core is at an absurd interest rate of 13.1%.  Therefore, it's not accurate to state that BlockFi made a bad deal that cost them $80m if they somehow got nothing back.  Instead, if these loans were outstanding for a year, the actual loss would only be $70m, because of the enormous interest paid in the interim.  In fact, interest payments are likely the largest expense for Core and the reason they are going bankrupt in the first place.  If, however, it does turn out that BlockFi's contract deferred interest payments until the end of the loan, that would pose questions about why such a contract was negotiated in the first place, and clarity should be obtained from BlockFi about that.

In short, it would take many failures on the scale of Core to have a significant impact on BlockFi.  This one failure alone poses little risk to anyone with money at BlockFi, even in the worst case.

 

Tether

Over the past few months, I've come to the conclusion that most people in cryptocurrency underestimate the probability of Tether's collapse.  I believe that predictions at Metaculus of 5% over the next two months (https://www.metaculus.com/questions/9121/tether-collapses-in-2022/) are accurate.  Tether is risky because it avoids US jurisdiction despite holding US dollars, it has paid government fines, it held commercial bonds as backing, its bank accounts were stolen in a complex and confusing incident, it has depegged from $1 multiple times in its history, and the list goes on and on.  

Tether's collapse would likely bring down the entire lending market, because all of the lenders except Ledn are accepting Tether as collateral, and Genesis is borrowing it from customers.  Unlike good collateral such as bitcoin that would crash reasonably slowly, would never hit zero, and which could be sold out over time, Tether's collapse would see Tether become worthless almost overnight just like Terra did.  Loans would become uncollateralized, and if people were using those loans to buy bitcoins, those borrowers would default if the bad news caused bitcoin to decline at the same time.

In the past, Tether was necessary because it was the only way to move dollars between exchanges outside of the banking system.  Now, there are numerous regulated stablecoins that are subject to strict licensing, are audited, and which the public knows are backed by high-quality assets like T-bonds.  If T-bonds default, then the dollars that stablecoins represent would become worthless anyway, so using such assets with that kind of backing adds zero additional risk.  Given that, why are lenders still holding Tether as collateral at all?

It doesn't take much for contracts to be modified such that when a lender receives Tether as collateral, it immediately redeems the Tether into some other stablecoin.  Tether will never be worth more than $1, so the lenders are not at risk of defaulting on returning the collateral to the borrower due to a price increase.  To protect against that, the contract could be written such that in the unlikely case Tether does become worth more than $1, the collateral would be paid at 1:1.  Therefore, the Tether is either returned at a 1:1 ratio, or if Tether collapses, the borrower gets nothing back upon repaying the loan.  Another option is to simply not accept Tether and insist on USDC or something else.  Every other stablecoin is better than Tether, and these lenders have the leverage to impose that condition.

While BlockFi understands that Tether is not real money, I want to see BlockFi include in their Q3 Transparency Report how much of their collateral is in Tether, and people should start asking everyone they lend to why they are involved in Tether at all anymore given how it's trivial to switch to better stablecoins.

 

Secured borrowers

With the one glaring exception of the gross negligence practiced by Voyager CEO Steve Elrich in lending to 3 Arrows, almost all of the loans that have failed across the industry have been secured loans.  That makes sense, because the reason that unsecured loans are being offered to some borrowers is because those borrowers are much more trustworthy than the secured lenders.  Too much attention is focused on unsecured loans, while lenders to these companies should really also be paying close attention to who the companies' secured borrowers are.

A key issue with secured borrowing is that defaults are likely to be correlated, rather than independent.  In the event of a failure, it's likely that the collateral value of all the secured borrowers will all decline at the same time, such as how a decline in the price of bitcoins might cause the GBTC fund to decline even further below net asset value.

The secured borrowers are the most likely to default, and therefore quality of the collateral for the secured borrowers is key.  Mining rigs, Tether, and the Grayscale funds are examples of poor quality collateral that should all be questioned.  Stating that something is "secured" does not make it safer than an unsecured loan automatically; on the contrary, it may actually be riskier.

 

Gaming the credit card system

Rates above 12% are now attainable for year-long loans.  Suppose, however, that you need open-term loans because you need to spend the money on living expenses over the course of the year.  Open-term dollar lending has crashed to half the profitability of what it once was.  However, there currently exists a significant gap in the credit card system which has not adjusted to the Fed's interest rate policy.

Currently, the Wells Fargo Reflect card offers a zero interest rate for 21 months.  There are many similar cards that offer zero rate terms of 18 months or 15 months.  I was able to get a $20,000 credit limit on the Wells Fargo card, so our strategy is to simply charge every single purchase to this card, keeping a few hundred dollars in a bank account to pay the 12 minimum payments.  When that card is full, I'll open a second card, until my credit score gets so low that I start to be rejected for new applications or I don't need any more credit.  The money I would have spent on both personal and business expenses like meals ($7,000), rent ($9,000), hosting and server costs ($44,000), and other lesser costs like gas gets charged to these cards.  On these $60,000 in expenses, I will earn $8,000 in interest.  After a year, I'll call the loan, pay down the debt, and cancel the cards - leaving the banks with a loss.

Earning 13% is more than enough to justify the credit risk of this scheme.  Lending dollars to BlockFi or Genesis for less than 3%, which is what you would earn on a 5.92% open-term loan that is drawn down to pay expenses over the course of the year, is not.

 

Conclusions

In conclusion, there are few changes in the market compared to the October 2022 report.  There is little change in the perceived risk for any of the lenders, but Genesis is offering better rates than they did in October.  The conclusions change only slightly:

• If you can get an LLC together with $2m or more, then lend to Genesis for 4 to 8 month terms, which have exceptional interest rates.
• If you can only get $250,000 together, then create an LLC and lend to BlockFi.  Also lend to BlockFi for shorter and open-term loans, which Genesis isn't attempting to match.
• For open-term loans for small clients for cryptocurrencies, both BlockFi and Genesis (through Gemini) are good choices.  If you have access to both, it's time to start moving money from Gemini to BlockFi as Genesis forces lower open-term rates upon Gemini.
• Dollar loans are now only worthwhile for fixed terms.  The 6% open-term rates are not worth the risk compared to the methods that exist to game the credit card system in the current high interest rate environment.